A new category of debt mutual funds, created to offer investors better after-tax returns, is struggling to make its mark despite a rapid rise in the number of such offerings. These 'income plus arbitrage’ funds have grown to 22 in less than two years of launch, with sector majors such as HDFC Mutual Fund and Sundaram Mutual Fund launching their schemes this year.

Investor flows into these schemes are reversing. After pouring ₹21,000 crore into income arbitrage funds in 2025, investors have pulled out around ₹2,000 crore this year through 31 July, according to MFI360 Explorer, a fund research tool from Icra Analytics.

An income plus arbitrage fund combines debt investments for interest income with arbitrage strategies that seek to capture the spread between cash and futures prices. It is aimed at investors seeking relatively stable returns from a mix of debt and arbitrage. Since returns are taxed like equity, the key pitch is the potential for higher after-tax returns.

They remain to be tested over the medium- to long-term, but in the short-term, the returns are mixed. They are lagging arbitrage funds and very short-term debt funds, but are slightly ahead of some traditional debt fund categories.

On average, income plus arbitrage funds gained 5.7% over the last year through 11 August, according to Value Research. In comparison, money market debt funds are up 6.22% on average, short-duration debt funds are up 5.33%, while corporate debt funds are up 5.43% over the period. Arbitrage funds, which are relatively lower risk hybrid funds, are up 5.73% over the last one year, according to Value Research.

“There is no direct comparable category,” said Narendra N. Kondajji, founder of Prokens Opesmetrics Pvt Ltd, a mutual fund distributor based in Bengaluru.

Income arbitrage funds invest in various debt funds, either from the same fund house or other companies. Since they don’t have a single type of debt investment, they can’t be easily compared to say only a short- or long-term debt or a low or high-quality debt fund. While Kondajji uses income arbitrage funds for some of his very wealthy clients, he said that for many individual investors this may not make sense. “This typically is not suitable for simple portfolios,” he said.

Mint takes a look at the promise and portfolios of income plus arbitrage funds so far.

The Theory

Income plus arbitrage funds, earlier called debt advantage, made an appearance in 2024 with a pitch to provide tax-efficient debt fund returns for wealthy investors. Of the 22 such funds available today, many are existing debt funds repackaged in the income arbitrage structure.

Their pitch is to provide slightly more than debt fund returns, without taking on the risk of equity, and a potential tax benefit for wealthy investors.

Typically, such a fund allocates at least 35% of its portfolio to an arbitrage fund, and the rest to debt funds. The arbitrage fund invests primarily in stocks, while using futures contracts and other derivatives to hedge against the equity risk. By holding at least 35% in an arbitrage fund, the income plus arbitrage fund qualifies for lower taxation. In other words, if such a fund is sold after two years or more, the capital gains are taxed at 12.5%.

In comparison, gains on selling a traditional debt fund are taxable at an individual’s income tax slab rate, which can be 30% or more for wealthy individuals.

Income plus arbitrage funds are best suited for specific investors in the 25% or higher tax bracket who want to park money for a two-three year timeframe, said Aarati Krishnan, head of advisory, PrimeInvestor Financial Research Private Ltd, a Sebi-registered portfolio manager based in Chennai.

Variety of debt

Analysts say income plus arbitrage funds are difficult to compare directly with traditional debt funds because their portfolios can hold different types of debt investments, rather than sticking to a single category based on duration or credit quality.

The two largest funds in this category—the Kotak Income Plus Arbitrage Omni Fund of Funds, with around ₹7,900 crore in assets end July, according to ICRA and ICICI Prudential Income Plus Arbitrage Omni fund, with ₹3,200 crore in assets—keep 30-32% of their portfolios in corporate debt funds and 8-10% in a fund that buys state development loans. Kotak also invests around 20% in a short-term debt fund, while ICICI Pru has 13% in a gilt fund that invests in government bonds issued by the government. Both funds are largely in very high quality debt, rated AAA, which according to credit rating agencies are companies with lower risk of default.

By holding debt funds of different qualities and of duration, these funds introduce risks that the average investor may not fully understand, said M. Pattabiraman, an associate professor at Indian Institute of Technology, Madras, and founder of personal finance platform Freefincal.

For instance, most people would consider gilts or government debt to be very safe but it can be “extremely risky”, said Pattabiraman. Though government debt is not expected to go bust as it is backed by the sovereign, if the bonds are of a long duration, their price or net asset value (NAV) can fall, depending on demand and supply, which investors may not be prepared for.

“I want a simple clean debt fund with a lower tax, but if I look at the strategy (of income plus arbitrage), it's very complex,” he said. “That’s my problem.”

Most income plus arbitrage funds today leave it up to the fund manager to choose the quality or duration of debt funds to buy and to change this mix as per her discretion. This makes it hard for the average investor to know what to expect, he added.

To complicate things, some funds call themselves income plus arbitrage 'omni' funds, some others are ‘active’ funds, and the rest are just income plus arbitrage funds. There is no standard definition of these categories. At HDFC Mutual Fund, which has both Income Plus Arbitrage Active FoF and HDFC Income Plus Arbitrage Omni FoF, the difference is basically that the ‘omni’ fund can also own index-based debt funds, while the ‘active’ fund only owns actively-managed debt funds.

“We need products with very narrow mandates,” said Pattabiraman. He advised investors to consider a debt index fund instead for their debt allocation, though there are only a handful of these in India today.

Specific use cases

Income plus arbitrage funds are an answer for specific needs, said Kondajii, the Bengaluru-based adviser. He uses them for his very wealthy clients in the highest tax brackets, and that too just for certain use cases.

One is if they are retirees looking to draw down their portfolios or to fund a certain expense within the next two to three years. He has invested a part of these retirees’ money, for which the use may not be clear. “They want something to do with this money, they don’t know what to do as of now, and they don’t want to get stuck in banks,” he said. By keeping that money in the income plus arbitrage, Kondajii hopes to provide them better returns than bank fixed deposit rates, especially after the 12.5% tax-kicker.

While the returns of income arbitrage funds have lately been middling, Kondajii believes that in the long-term, their benefits will show, especially for those invested in high-quality debt. “You just have to go through one bad cycle, and then you’ll know the worth of it,” he said, while adding that he steers clear of funds with lower rated debt.

Some advisers believe income arbitrage funds are yet to gain popularity partly because, since their launch, they haven’t seen a period of falling interest rates that could have boosted their returns.

“Typically, people pay attention to a category when there’s a sudden short-term gain,” said Vishal Dhawan, co-founder of Plan Ahead Wealth Advisors Pvt., an investment advisory firm in Mumbai. Moreover, he said, investors are also not fully aware about how these funds work.

“It’s like all new categories,” said Dhawan. When arbitrage funds first came out, there was a lot of scepticism but now people are comfortable with it, Dhawan said, adding that he expects a similar trend for income arbitrage funds. There tend to be some inflection points that change people’s attitudes, he said.

He, however, signed off with advice that investors looking at these funds need to do their research well. “The investor needs to go in there and see what’s happening.”

A new category of debt mutual funds, created to offer investors better after-tax returns, is struggling to make its mark despite a rapid rise in the number of such offerings. These 'income plus arbitrage’ funds have grown to 22 in less than two years of launch, with sector majors such as HDFC Mutual Fund and Sundaram Mutual Fund launching their schemes this year.

Investor flows into these schemes are reversing. After pouring ₹21,000 crore into income arbitrage funds in 2025, investors have pulled out around ₹2,000 crore this year through 31 July, according to MFI360 Explorer, a fund research tool from Icra Analytics.

An income plus arbitrage fund combines debt investments for interest income with arbitrage strategies that seek to capture the spread between cash and futures prices. It is aimed at investors seeking relatively stable returns from a mix of debt and arbitrage. Since returns are taxed like equity, the key pitch is the potential for higher after-tax returns.

They remain to be tested over the medium- to long-term, but in the short-term, the returns are mixed. They are lagging arbitrage funds and very short-term debt funds, but are slightly ahead of some traditional debt fund categories.

On average, income plus arbitrage funds gained 5.7% over the last year through 11 August, according to Value Research. In comparison, money market debt funds are up 6.22% on average, short-duration debt funds are up 5.33%, while corporate debt funds are up 5.43% over the period. Arbitrage funds, which are relatively lower risk hybrid funds, are up 5.73% over the last one year, according to Value Research.

“There is no direct comparable category,” said Narendra N. Kondajji, founder of Prokens Opesmetrics Pvt Ltd, a mutual fund distributor based in Bengaluru.

Income arbitrage funds invest in various debt funds, either from the same fund house or other companies. Since they don’t have a single type of debt investment, they can’t be easily compared to say only a short- or long-term debt or a low or high-quality debt fund. While Kondajji uses income arbitrage funds for some of his very wealthy clients, he said that for many individual investors this may not make sense. “This typically is not suitable for simple portfolios,” he said.

Mint takes a look at the promise and portfolios of income plus arbitrage funds so far.

The Theory

Income plus arbitrage funds, earlier called debt advantage, made an appearance in 2024 with a pitch to provide tax-efficient debt fund returns for wealthy investors. Of the 22 such funds available today, many are existing debt funds repackaged in the income arbitrage structure.

Their pitch is to provide slightly more than debt fund returns, without taking on the risk of equity, and a potential tax benefit for wealthy investors.

Typically, such a fund allocates at least 35% of its portfolio to an arbitrage fund, and the rest to debt funds. The arbitrage fund invests primarily in stocks, while using futures contracts and other derivatives to hedge against the equity risk. By holding at least 35% in an arbitrage fund, the income plus arbitrage fund qualifies for lower taxation. In other words, if such a fund is sold after two years or more, the capital gains are taxed at 12.5%.

In comparison, gains on selling a traditional debt fund are taxable at an individual’s income tax slab rate, which can be 30% or more for wealthy individuals.

Income plus arbitrage funds are best suited for specific investors in the 25% or higher tax bracket who want to park money for a two-three year timeframe, said Aarati Krishnan, head of advisory, PrimeInvestor Financial Research Private Ltd, a Sebi-registered portfolio manager based in Chennai.

Variety of debt

Analysts say income plus arbitrage funds are difficult to compare directly with traditional debt funds because their portfolios can hold different types of debt investments, rather than sticking to a single category based on duration or credit quality.

The two largest funds in this category—the Kotak Income Plus Arbitrage Omni Fund of Funds, with around ₹7,900 crore in assets end July, according to ICRA and ICICI Prudential Income Plus Arbitrage Omni fund, with ₹3,200 crore in assets—keep 30-32% of their portfolios in corporate debt funds and 8-10% in a fund that buys state development loans. Kotak also invests around 20% in a short-term debt fund, while ICICI Pru has 13% in a gilt fund that invests in government bonds issued by the government. Both funds are largely in very high quality debt, rated AAA, which according to credit rating agencies are companies with lower risk of default.

By holding debt funds of different qualities and of duration, these funds introduce risks that the average investor may not fully understand, said M. Pattabiraman, an associate professor at Indian Institute of Technology, Madras, and founder of personal finance platform Freefincal.

For instance, most people would consider gilts or government debt to be very safe but it can be “extremely risky”, said Pattabiraman. Though government debt is not expected to go bust as it is backed by the sovereign, if the bonds are of a long duration, their price or net asset value (NAV) can fall, depending on demand and supply, which investors may not be prepared for.

“I want a simple clean debt fund with a lower tax, but if I look at the strategy (of income plus arbitrage), it's very complex,” he said. “That’s my problem.”

Most income plus arbitrage funds today leave it up to the fund manager to choose the quality or duration of debt funds to buy and to change this mix as per her discretion. This makes it hard for the average investor to know what to expect, he added.

To complicate things, some funds call themselves income plus arbitrage 'omni' funds, some others are ‘active’ funds, and the rest are just income plus arbitrage funds. There is no standard definition of these categories. At HDFC Mutual Fund, which has both Income Plus Arbitrage Active FoF and HDFC Income Plus Arbitrage Omni FoF, the difference is basically that the ‘omni’ fund can also own index-based debt funds, while the ‘active’ fund only owns actively-managed debt funds.

“We need products with very narrow mandates,” said Pattabiraman. He advised investors to consider a debt index fund instead for their debt allocation, though there are only a handful of these in India today.

Specific use cases

Income plus arbitrage funds are an answer for specific needs, said Kondajii, the Bengaluru-based adviser. He uses them for his very wealthy clients in the highest tax brackets, and that too just for certain use cases.

One is if they are retirees looking to draw down their portfolios or to fund a certain expense within the next two to three years. He has invested a part of these retirees’ money, for which the use may not be clear. “They want something to do with this money, they don’t know what to do as of now, and they don’t want to get stuck in banks,” he said. By keeping that money in the income plus arbitrage, Kondajii hopes to provide them better returns than bank fixed deposit rates, especially after the 12.5% tax-kicker.

While the returns of income arbitrage funds have lately been middling, Kondajii believes that in the long-term, their benefits will show, especially for those invested in high-quality debt. “You just have to go through one bad cycle, and then you’ll know the worth of it,” he said, while adding that he steers clear of funds with lower rated debt.

Some advisers believe income arbitrage funds are yet to gain popularity partly because, since their launch, they haven’t seen a period of falling interest rates that could have boosted their returns.

“Typically, people pay attention to a category when there’s a sudden short-term gain,” said Vishal Dhawan, co-founder of Plan Ahead Wealth Advisors Pvt., an investment advisory firm in Mumbai. Moreover, he said, investors are also not fully aware about how these funds work.

“It’s like all new categories,” said Dhawan. When arbitrage funds first came out, there was a lot of scepticism but now people are comfortable with it, Dhawan said, adding that he expects a similar trend for income arbitrage funds. There tend to be some inflection points that change people’s attitudes, he said.

He, however, signed off with advice that investors looking at these funds need to do their research well. “The investor needs to go in there and see what’s happening.”